If the installment sale method is used to report the sale, sellers can recognize profits and tax gains proportionately over time for eligible property. The buyer also receives a fully stepped-up basis in acquired property. This allows the buyer to take depreciation deductions based on the purchase price without paying the full amount wasn’t exchanged at closing.
Installment sales can get deals done when buyers have limited access to bank financing. Essentially, sellers finance the deal. While advantageous for the buyer, the seller bears default risk in the transaction.
The seller also bears risk in future tax policies. Increasing tax rates are detrimental to the seller as they reduce net proceeds. However, there is some upside potential if tax rates decrease in the future. In addition, depreciation recapture must be reported as a gain in the year of the sale. This applies even when it exceeds the installment payment the seller received in that year.
Not all transactions are eligible for the installment method. For example, inventory sales and transactions involving related parties are ineligible.
Consulting and noncompetes
After closing, sellers can facilitate management changes as an employee or consultant. This continuity can reduce turnover, minimize disruptions, and build trust with long-term employees, suppliers, and customers.
It is possible for sellers use their business contacts and specialized knowledge to compete with the business they just exited. To avoid this, buyers should consider adding restrictive covenants, such as noncompetes or nonsolicitation provisions, to the purchase agreement. These restrictive covenants prevent sellers from:
The parties should negotiate the purchase price allocation for consulting agreements and restrictive covenants. These allocations have tax and financial reporting consequences that must be considered.
Negotiating an optimal deal structure takes time, patience, and financial knowledge. A valuation specialist can help you understand the financial implications of creative deal terms.